Stock Market Investment: 10 things you must know before investing in stock markets

Updated: June 4, 2018 1:15 PM

The stock market can help you make a lot of money, but you can lose all your money if you are tempted to invest randomly without knowing the nitty-gritty of the market. Here's what you need to know about the market.

Before making your first investment, take the time to learn the basics about the stock market and the individual securities composing the market.

If you are thinking of investments that could beat inflation and also give you good returns, one option might be to start investing in the stock market. If you have decided to do the same and go for it all by yourself, it’s not a bad idea. The stock market, when properly understood, can help you make a lot of money, but you can also lose all your money if you are tempted to invest randomly without knowing the nitty-gritty of the market.

Therefore, there are a few things you must know before you dive into the share market. Here they go:

1. Never jump blindly into stock markets

Many a times it happens that while talking to your friends and colleagues, the discussion heads towards the stock market, and also how the stock market helps investors make big money. You might never have invested in the market, but after hearing about all those things you also decide to buy some stocks. However, if you entered the market just to remain in the mainstream fashion, you have landed in for the wrong reason. You should invest in the stock market after getting the basic knowledge about it and in accordance with your financial goals.

2. Stock market is not a money-making machine

You must have heard the story about many investors who made their fortune through the market. Many believe that the stock market is like a money-making machine, which can turn them into millionaires over a period of time. Well, it is true that a lot of investors have made profits through the stock market. But it was only possible because they’ve good market knowledge, made some really smart choices by adopting carefully thought of strategies, and are also much disciplined in their approach. Many people forget that a lot of people have lost their entire wealth, while some have been forced to sell their personal assets to cover the loss in the market.

3. Educate yourself, handle basics first

Before making your first investment, take the time to learn the basics about the stock market and the individual securities composing the market. There is an old adage: It is not a stock market, but a market of stocks. Your focus will be upon individual securities which you are investing in and the relationship with the broader economy and the factors that drive your stock. Some important areas which you should be familiar with before entering the market are:

# Understanding financial metrics and definitions such as PE, EPS, ROE, Market Cap and so on

# Popular Methods of Stock Selection and Timing, such as fundamental and technical analyses

# Gain some understanding about the market and its relationship with the economy such as market relationship with inflation, GDP, fiscal deficit, crude prices, rupees values against dollar. People lose money in the markets because they simple jump to the market without understanding the economic and investment market cycles.

4. Invest only your surplus funds

The biggest mistake newbie investors make is to invest money that they can’t actually afford to lose. Investing in the stock market is risky, and that means that you can potentially lose everything. Like any investment, there are inherent risks associated with the stock market. Some are the risks related to the overall market as systematic risk that you can’t avoid by diversifying your portfolio, while some risks are stock-specific that you can avoid. You need to decide your own risk tolerance considering your age, financial strength, retirement goal, etc, and accordingly should take the risk. If you want to take risk in the stock market, then only invest your surplus funds which you can afford to lose. Investment is done to generate more money, but do not invest all your emergency funds in the stock market.

5. Avoid Leverage

Leverage simply means use of borrowed money to execute your stock market strategy. In a margin account, banks and brokerage firms can lend you money to buy stocks. It sounds great when the stock market is moving up, but consider the other side when the stock market or your stock goes down. In that case your loss would not only erode your initial investment, but you will also have to pay interest to the broker. Leverage is, thus, a tool, neither good nor bad. However, it is best used after you gain experience and confidence about your decision-making abilities. Therefore limit your risk when you are starting out to ensure you can profit over the long term.

6. Avoid herd mentality

Unlike many investors do, you should avoid the herd mentality that is influenced by the actions of your acquaintances, neighbors or relatives without evaluating the current information and underlying stocks. Thus, if everybody around is investing in a particular stock, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long run if you have not chosen the stock by careful analysis. So, if you really don’t understand about the stock, never step in. Before investing in a company, you should know about its business. It’s important to only invest in businesses that are easy for you to understand, especially while you’re just starting out. Never invest in a stock. Invest in a business instead.

7. Diversify, but refrain from over diversification

Never put all your money in one stock. Create a well-diversified portfolio of stocks that can help you reduce the risk and save you from losing money if a few stock do not perform well. Also, avoid over diversification, as increase in the number of stocks up to a certain limit do help in diversifying the risk proportionately, but beyond a certain number of stocks your investment can’t get the proper growth moment.

8. Don’t try to time the market, follow a disciplined investment approach

A majority of investors try to time the market, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process. No one is able to successfully and consistently time the market by catching the tops and bottoms over multiple business or stock market cycles. You can invest over a period small amounts of money to average the market and can get the benefit in the long term. Investors who put in money in right shares systematically over the long term generate outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind.

9. Don’t let emotions impact your investment

Separate your emotion from any particular stock as many investors end losing money in the stock markets due to their inability to control emotions. Get rid of the fear and greed cycle. Do not invest in any speculative unknown stock lured by its past fabulous return without understanding the risk involved that will lead you to suffer loss. In a bear market, control your fear and don’t panic and sell shares at rock-bottom prices. Thus, fear and greed are the worst emotions to feel when investing, and it is better not to be guided by them.

10. Have realistic expectations

Hoping for the ‘best’ from your investments is not wrong, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, lots of stocks have generated more than 100 per cent returns during the great bull run of recent years. However, it doesn’t mean that you should always expect the same kind of return from the stock markets. If you feel that stocks in your portfolio are overvalued, it is better to switch to a relatively low value good stock.

Lastly it’s important to monitor your investment and review it periodically as any important event happening in any part of the world does have an impact on our financial markets. Also, any news or financial event related to a particular stock or industry impacts that stock.